Recent Volatility in Stock Markets in India and Foreign Institutional Investors Parthapratim Pal Section 1. Introduction After the first few phases of polling of the general election in India, there was a sudden and sharp increase in stock market volatility in this country. Apparently, the prospect of a non-BJP government in the center made the big players in the stock market nervous about the continuation of the ongoing reform measures in India. Largely owing to selling pressures from foreign institutional investors (FIIs), the Bombay Stock Exchange Sensitivity Index (Sensex) declined from about the 5,900 on 22 nd April to around 4,500 on May 18 th . On 17 th May, it registered a record 800 point decline, which is the steepest fall in the 130-year-old history ofthe stock exchange, before recovering to close 564 points lower. To calm these investors, seniorCongress leaders had to issue statements reaffirming their faith in the market oriented ‘reform’ measures. Even though the verdict of the general election was seen as a mandate against the neo-liberal economic policies pursued by the outgoing government, the upheavals of the stockmarkets managed to influence the new government’s policies even before the new ministry was formed. The apparent ease in which the stock market and institutional investors managed to influence policymaking created a debate in India. In the financial media there was a view that the decline of the Sensex happened because major ‘market’ players was wary about the political stability ofthe new regime and they did not approve of the policy statements made by some of the leaders of the United Progressive Alliance. These investors showed their disapproval and lack ofconfidence in the new government by withdrawing from the market. However, many analysts suspected that it was an at tempt by financial rentiers, particularly foreign institutional i nvestors, to overrule the anti-reform verdict delivered in the election and nudge policy makers towards adopting neo-liberal policies which essentially suit these investors. Given this controversy, this paper aims to take a detailed look at the stock market and the behavior of different investor groups, especially the FIIs, in India for the period March 2004 to June 2004. The objective of the paper is also to investigate how the withdrawal of foreign portfolio capital in the post election phase has affected the price and equity holding pattern ofdifferent Sensex companies. This will help us understand the dynamics of the stock market crash in the post election period. This paper is organized in the following manner. Section 2 looks at the movement of the Sensex and measures its volatility in the recent months, section 3 investigates the pattern of foreign portfolio investment and its influence on the Sensex, section 1
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The churnings of stock prices led to a sharp rise in stock market volatility in May. To measure
how much the volatility increased during that month, the following two methods of estimating
inter and intra day stock market volatility is used here. These measures are suggested in a
recent SEBI Publication on volatility by Raju and Ghosh (2004).
The first formula measures inter day volatility by computing standard deviation of daily returns
on stock prices. In this method, the formula used for calculating volatility is
σ =2*)()1/1( r r n t −− ∑ where… r t = ln(I t /I t-1)
I t is the closing value of the stock market index at time t,
ln is natural logarithm
The second formula uses intra day High and lows of stock market prices and estimate intra-day
volatility. The following formula is used in this case:
σ =2
)/(log(/1 t t L H nk where H t and Lt are intra day high and low prices,
and following Parkinson (1980), k is taken as 0.601
Daily Sensex data are used for estimation of volatility. Data are taken from the Bombay Stock
exchange website (www.bseindia.com)
Calculations show that both inter and intra day volatility of BSE Sensex followed similar trend
during 2004. From January to April, both intra and inter day volatilities of Sensex were on a
decline and were below the 1.5 mark. Suddenly in May there was a spike in volatility and bothinter and intra day volatility almost doubled for that month. However, after May, volatility has
again subsided and has settled down to levels observed during the earlier part of the year
It is an accepted fact now that FIIs have significant influence on the movements of the stock
market indexes in India. If one looks at the total FII trade in equity in India and its relationship
with the stock market turnover, it shows a steadily growing influence of FIIs in the domestic
stock market. Figure 6 shows total trade (gross purchase + gross sales) of FIIs in Indian equities
as a percentage of total turnover of the Bombay Stock Exchange.
It should be noted here that the figure may not be an accurate measure of FII dominance
because it suffers from two shortcomings. First, it takes into account the turnover of only the
Bombay Stock Exchange and secondly, if one uses gross sales plus gross purchase by FIIs to
measure FII turnover then it double counts the intra-FII trading. Therefore, the figure shows an
upward bias in the measure of FII dominance4. However, if one uses time series data, the total
FII trade to BSE turnover ratio, in spite of its limitations, gives us an idea about the trend of FII
dominance in the domestic stock market.
Fig 6. Total FII Trade (Gross purchase + Gross Sales) as a percentage of Total
Turnover in Bombay Stock Exchange
0
10
20
30
40
50
60
1 9 9 2 - 9 3
1 9 9 3 - 9 4
1 9 9 4 - 9 5
1 9 9 5 - 9 6
1 9 9 6 - 9 7
1 9 9 7 - 9 8
1 9 9 8 - 9 9
1 9 9 9 - 0 0
2 0 0 0 - 0 1
2 0 0 1 - 0 2
2 0 0 2 - 0 3
2 0 0 3 - 0 4
%
Source: RBI Handbook of Statistics and SEBI Annual Reports, various issues
Figure 6 shows that the influence of FIIs in the domestic stock market is on a steady increase
over the last few years and in 2003-04 the share of total FII trade in domestic stock market
turnover has increased very sharply. This indicates that, at the margin, FIIs are becoming more
important and their influence on the market is significant.
In fact, even in 2000-01, when the share of FII trade in domestic turnover was much less, it was
recognized that the FIIs have disproportionately high level of influence on the movement of
4
Also, some amount of FII investment can be in the primary market as well, however, FII investments in primarymarket generally have been quite low in India.
stock indices in India. The 2001 edition of National Stock Exchange’s annual publication,
Indian Stock Market Review says:
“Though the volume of trades done by FIIs is not very high as compared to other market
participants, they are the driving force in determination of market sentiments and price trends.
This is so because they do only delivery-based trades and they are perceived to be infallible in
their assessment of the market.” Pg. 125
Apart from the psychological
factors mentioned in NSE
(2001), the influence of FIIs
on the movement of Sensex
will also become clear if one
looks at the shareholding
pattern of the 30 companies
that constitute the index.
Shareholding data is available
on a quarterly basis from the
CMIE Prowess database and
the SEBI EDIFAR website. Figure 7 shows average shareholding data for the 30 Sensex
companies for the latest quarter (June 2004). It shows that average equity holding by the FIIs is
more than 20 percent in the Sensex companies5. It also shows that as an investor group, FIIs are
the biggest non-promoter shareholders of the Sensex companies6.
Figure 7. Average Shareholding Pattern of Sensex
Companies - June 2004
Other
7.8%
Private
Corporate
Bodies
2.8%
Indian Public
12.5%
Promoters
37.2%
Mutual Funds
and UTI
4.5%
NRIs/OCBs
3.2%
FIIs
21.6%Banks, FIs,
Insurance cos
10.4%
However, this figure masks the fact that FIIs hold a much higher percentage of shares that are
normally available for trading in the market (free float shares). For example, in Bharat Heavy
Electricals Limited, FII shareholding was 20.6 percent in June 2004, but free float adjusted
shareholding of FIIs is more than 58 percent in that company. As mentioned before, share
holding by promoters, government, strategic investors and other some other investments like
holdings through FDI route, strategic stakes by private corporate bodies and individuals and
equity held by employee welfare trusts do not normally enter the open market and therefore do
not directly influence share prices. Therefore, to judge the real influence of the FIIs on the
share prices of Sensex companies, it is important to see what percentage of free-float shares of
5 It is notable here that RBI’s ceiling for overall investment limit for FIIs is 24 per cent of the paid up capital of a
company. But there are numerous exceptions, which allow Indian companies to raise this limit to even 100 percentof the paid up capital. See the following link for more detail:
mentioned here again that share prices of all these 24 companies have declined during the
March–June phase.
Four Sensex companies witnessed a decline of FII shareholding between 1 to 3 percentage
points. Interestingly, Wipro and Infosys belong to this set of companies and it can be pointed
out here that these are the only two Sensex companies which did not witness a price decline
between March and June 2004. For only 2 Sensex companies (TISCO and Dr. Reddy’s), FII
shareholding declined by more than 3 percentage points. This result is summarized in Table 5a.
As these findings are not on the expected line, to further probe into the matter, the number of
equities held by the FIIs over the reference period is looked at. These results are summarized in
Table 5b. It can be seen from the table that the absolute number of equities held by the FIIs
have increased for 10 companies. And only for one company, the number of equities held by
FIIs has actually declined by more than 3 percent.
Table 5a. Change in FII Shareholding in Sensex Companies As a percentage of Total Shareholding
FII shareholding not decreased 12
Decreased by less than 1 percentage point 12
Decreased by more than 1 percentage point but less than 3 percentage point 4
Decreased by more than 3 percentage point 2
Total 30
Table 5b. Change in Number of Shares Held by FIIs in Sensex Companies(in percentage)FII shareholding not decreased 10
Decreased by less than 1 percent 13
Decreased by more than 1 percent but less than 3 percent 6
Decreased by more than 3 percent 1
Total 30
Note: Between March and June, the total equity bases of some companies have changed. For example,
Wipro declared a bonus issue in April 2004 and ICICI bank has new issued new equity share during this
period. Adjustments have been made to take these factors into account.
Given the fact that shareholdings of FIIs in Sensex companies have not changed significantly,
the relationship between price change of the Sensex companies and change in FII shareholding
is investigated. The findings are presented in figure 9 and figure 10. It is to be noted here that
for both figure 9 and 10, adjusted closing prices of Sensex companies are taken. Adjusted
prices are reported by the Prowess database8. Figure 9 shows the relationship between price
changes of Sensex companies with change in FII shareholding pattern in these companies.
8 According to the Prowess manual “Share prices are adjusted when there is a change in face value of the scrip or thecompany makes a bonus issue or a rights issue. In the case of a rights issue, the adjustment is done only when the
rights issue is that of equity shares or convertible debentures. There is no adjustment for a rights issue of non-
convertible debentures. Adjustments are carried out as given above and the following fields stand for, the adjustedclosing, opening, high and low price, respectively”.
future growth prospects of the economy9. Moreover, this study also shows that even sharp
changes in Sensex do not necessarily indicate a significant alteration of actual shareholding
pattern of different investor groups even in the Sensex companies. As far as the real economy is
concerned, the stock market has a very limited role to play. In India, for the year 2002-03, new
capital issues by non-government public limited companies raised a combined capital of Rs
1,878 crores from ordinary shares, preference share and debentures. This amount is only 0.33
percent of gross domestic capital formation of the economy and about 1.6 percent of gross
domestic capital formation by private corporate sector for that year. This is not surprising
because even in developed stock markets like USA, the stock market has not been a significant
source of finance for new investments. Also, stock markets mobilize a very small fraction of
household financial saving in India. As the recent RBI Handbook of Statistics shows,
investment in shares and debentures10 and units of UTI account for only 1.37 percent of total
household financial savings for the year 2003-04. In comparison, bank deposits account for
about 42.8 percent of household financial savings for the same year. Under these
circumstances, it is not clear why so much importance is given to the stock market and portfolio
investors by policymakers in India. It is high time to realize that in spite of the impression
given by the financial media, movements of stock markets and Sensex do not necessarily imply
any fundamental changes in the economy and these movements affect a very small minority of
the country’s population. It will be unfortunate if movements of speculative capital and the
resultant stock market gyrations are allowed to influence macro-economic policymaking in
India.
References:
Centre for Monitoring Indian Economy (CMIE): PROWESS Database.
Chandrasekhar, C. P. (2004): “The Markets vs. The People: A tale of two mandates” -http://www.macroscan.org/the/finance/may04/fin170504Markets_vs.htm
Ghosh, Jayati (2004): “The Stock Market and the Real Economy”-www.macroscan.org/the/finance/may04/fin170504Stock_Market.htm
NSE (2001): Indian Securities Market: A Review, Volume IV, 2001, National Stock Exchange, Mumbai.
Pal, Parthapratim (1998): “Foreign Portfolio Investment in Indian Equity Markets: Has the Economy
Benefited?” Economic and Political Weekly, Vol. 33, No. 11, March 14.
Pethe, Abhay and Ajit Karnik (2000): “Do Indian Stock Markets Matter? Stock Market Indices andMacro-economic Variables” Economic and Political Weekly, January 29.
9 See Pethe and Karnik (2000), Ghosh (2004)10
Includes investment in shares and debentures of credit/non-credit societies, public sector bonds and investment inmutual funds (other than UTI)
Raju, M.T and Ghosh, Anirban (2004): “Stock Market Volatility – An International Comparison”-Working
paper series no. 8, Securities and Exchange Board of India, April 2004.
RBI: Handbook of Statistics on Indian Economy, Reserve Bank of India, Mumbai, various issues.
Samal, Kishor C., (1997): “Emerging Equity Market in India: Role of Foreign Institutional Investors”Economic and Political Weekly, Vol. 32, No. 42, October 18.
SEBI: Annual Report , Various Issues, Securities and Exchange Board of India, Mumbai.
Singh, Ajit and Weisse, Bruce A. (1998): “Emerging Stock Markets, Portfolio Capital Flows and Long-Term Economic Growth: Micro and Macroeconomic Perspectives”, Cambridge Discussion Papers inAccounting and Finance, AF30, University of Cambridge, March 1998.